Worth Its Salt?

Many of us hoped for a white Christmas, but S. Jay Stewart really needed one. As chairman of salt and specialty-chemical manufacturer
Morton International
, Stewart has suffered more from the unseasonably warm winter than most. With an international financial crisis and a strong dollar already chipping away at sales abroad, weak demand for Morton's ice-control products hardly could come at a worse time.

The double whammy of soft global growth and mild weather sent profits for the fiscal first quarter, ended September 30, tumbling 16%. That's helped to push down the company's share price by nearly a third from its peak.

But rather than fret the short-term challenges, Stewart is all smiles as he looks ahead to the next few years. The company, he believes, has a product in the works with blockbuster potential. It's called Lamineer, a powder coating for wood products that could revolutionize an industry and eventually pump up Morton's earnings.

Powder coating is a method of applying solid paint, instead of conventional liquid, to surfaces. While powder coatings have long been used to finish metal, the extreme heat needed to apply the colors has ruled out their use on wood. That was until Lamineer came along.

The technology, industry analysts say, could open new opportunities to apply powder coatings to everything from wooden kitchen cabinets to home and office furniture to finished products like shelves and moldings. Eventually, it may be used on plastics, involving items as diverse as automobiles and toys. "We view this as being as big or bigger than any opportunity this company has ever had," says Stewart. "We're pretty excited and bullish about it."

Here's how powder coating works: Pigments are applied with spray guns that administer electrostatic charges to the powder particles. Manufacturers of products like automobile parts, appliances, lawn and garden furniture, sports equipment, reinforced steel and piping currently use powder coatings. They prefer the process because it can improve productivity, cut labor and maintenance costs, and reduce safety risks at production plants, while also being sounder environmentally.

Morton isn't the first specialty-chemical firm to study wood applications for powder coating, but Stewart says it's well ahead of the pack, an assertion with which Wall Street analysts don't disagree. The company has made great strides in design, testing and marketing. More importantly, it has overcome key technical obstacles. Among them: to get powders to stick to wood even though it doesn't conduct electricity, and to be able to apply paint at low enough temperatures so that the wood isn't altered or damaged.

After four years of research, development and testing, Morton is beginning to sell Lamineer. As many as 50 companies are already working with the technology and are in various stages of testing. A handful are beginning to move from the development stage to commercial sales. Stewart estimates that Morton has racked up close to $10 million in initial sales. Office-furniture maker
Herman Miller
, which already uses powder coatings on metal products, is one company currently working with Lamineer and hopes to offer the finish in the near future.

But the pool of interested parties has swelled rapidly. Thanks to scattered publicity, more than 700 companies around the world have inquired about the product. Much of the buzz came after Morton won the 1998 Challengers Distinguished Achievement Award, presented at the International Woodworking Machinery and Furniture Supply Fair last August.

Initially, Morton is setting its sights on the decorative overlay market, or items made from high-density fiberboard, such as cabinets and other furniture. It's a huge market, with 1997 sales of roughly $2.5 billion in North America alone. Morton estimates the European market to be about the same size, bringing the global potential to at least $5 billion. And plans to apply Lamineer to hardwood products could double that market.

PaineWebber analyst Robert Ottenstein sees a "reasonable chance" that the new technology could become a blockbuster, generating perhaps $450 million in sales and 85 cents per share in earnings within a few years. Ottenstein says his "grass roots" research-based on conversations with powder-equipment manufacturers, wood producers and Morton's competitors-indicates Lamineer's potential isn't implied in Morton's current valuation.

Until now, he argues, the Morton story has consisted primarily of restructuring in its specialty-chemical businesses and share buybacks. The firm has bought back approximately 20 million shares since selling its profitable automotive airbag business in April 1997 and probably will buy back another eight million shares by April 1999.

Based on PaineWebber's calendar 1998 EPS estimate of $1.59, Morton sells just in line with the specialty-chemical group, at roughly 17 times estimated earnings, and at a 35%-40% discount to the Standard & Poor's 400 index of nonfinancial companies. Looking forward, Ottenstein thinks investors may start paying attention to Lamineer over the next 12 months, particularly if commercial trials translate into orders that show up in Morton's bottom line.

Against that backdrop, Ottenstein believes Morton's stock, changing hands last week at 25 and change, could jump as high as 33 over the next year and advises buying it below 30. Given that Morton is expected to raise earnings by 9%-10% without Lamineer, he says one could argue that, even at a share price of 33, the innovation wouldn't be reflected in the company's long-term valuation. And that would still leave the stock shy of its 52-week high of 35 1/8 .

Some analysts are less optimistic for the short term. "It's definitely a positive, and potential is there," says David Begleiter of Credit Suisse First Boston. But "it's too early to tell" whether Lamineer will be the huge success Morton hopes. While Begleiter continues to rate Morton a long-term "buy," he advises investors to keep an eye on the declines in profit margins in the specialty-chemical businesses in recent quarters. He also thinks Morton needs to continue its restructuring, which essentially entails getting rid of non-core businesses. The airbag spinoff was a good step in that direction.

Indeed, Lamineer's success isn't assured. While Stewart believes that Morton is sitting on a "transforming business opportunity," even optimists like Ottenstein put the chances of the new product's soon living up to Morton's hopes at "less than 50%." Delays in bringing it to market or quality-control problems could push any possible boost to Morton stock out a few years. Another risk is competition. While Morton is seen as the front-runner, there's always the possibility others could catch up.

But over the long term, it seems quite likely that Morton will enjoy a payoff from its budding wood-coating business. Begleiter says that investors looking for swift pop may be disappointed. Instead, he sees a three-to-five-year time horizon as realistic. A key reason is that the company faces some short-term challenges.

Timothy Gerdeman of Salomon Smith Barney recently reduced his earnings estimates for Morton, as well as his rating on the stock, to "neutral" from "outperform." Coming on the heels of a 33% drop in the company's fiscal-year 1998 ice-control salt sales, the current mild winter could put downward pressure on Morton's third- and fourth-quarter results.

At the same time, warm weather also is reducing consumption of home heating oil, cutting demand for Morton's fuel-dye products. Add to that some selling price erosion in specialty chemicals, particularly electronic materials, and it's not a pretty picture. Amid declining revenue, Morton's net income fell to $45.4 million, or 36 cents a diluted share, for the fiscal first quarter ended September 30.

Gerdeman had upgraded the stock in April 1998 amid hope that Morton would execute a major restructuring, such as separating its specialty chemicals and salt into two separately traded entities. Or that the company would drastically streamline what he sees as "fragmented" specialty-chemical operations, while utilizing its underleveraged balance sheet to make a large strategic acquisition. Neither scenario has come to pass, while earnings have eroded amid slowing global demand and weather-related issues. Thus, Salomon Smith Barney reduced its fiscal-years 1999 and 2000 EPS estimates to $1.57 and $1.77, respectively, from $1.65 and $1.85.

Stewart acknowledges that the combination of economic turmoil in Asia, pricing declines in some chemical product lines, a firm dollar and an historically warm winter continue to squeeze profits. And, to be sure, that's reflected in the decline in Morton's shares over the past year. But looking forward, Stewart plans to stay true to a strategy that's helped the 150-year-old company get through rough times before: Come up with new, innovative products.

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